A post last week reviewed a botched foreclosure for a mortgage loan in Ace Securities Home Equity Loan Trust 2007-HE4 dismissed with prejudice, meaning that the foreclosure cannot be refilled; a total loss for investors. Next, we reviewed why the trust has not yet recorded the loss despite the six month old verdict.

As an experiment, I gave my six year-old daughter four quarters. She just learned how to add coins so this pleased her. Then I told her I would take some number of quarters back, and asked her how many I should take. Her first response was one – smart kid – then she changed her mind to two, because we’d each have two and that’s the most “fair.” Having mastered the notion of loss mitigation and fairness, and because it’s not nice to torture six year-old children with experiments in economics, I allowed her to keep all four.

When presented with a similar question – whether to take a partial loss via a short-sale or principal reduction, or whether to take a larger loss through foreclosure – the servicers of ACE2007-HE4 repeatedly opt for the larger losses. While the dismissal with prejudice for the Guerrero house is an unusual, the enormous write-off it comes with through failure to mitigate a breach – to keep overall damages as low as possible – is common. When we look more closely at the trust, we see the servicer again and again, either through self-dealing or laziness, taking actions that increase losses to investors. And this occurs even though the contract that created the securitization, a pooling and servicing agreement, requires the servicer to service the loans in the best interest of the investors.

Let’s examine some recent loss statistics from ACE2007-HE4. In May, 2012 there were 15 houses written-off, with an average loss severity of 77%. Exactly one was below 50% and one, in Gary, IN, was 145%; the ACE investors lent $65,100 to a borrower with a FICO score of 568 then predictably managed to lose $94,096. In April, there were 23 homes lost, with an average loss severity of 82%, three below 50%, though one at 132%, money lent to a borrower with an original FICO score of 588.

Of course, those are the loans with finished foreclosures. There are 65 loans where borrowers missed at least four consecutive payments in the last year with yet there is no active foreclosure. Among those are a loan for $593,600 in Allendale, NJ, where the borrower has not made a payment in about four years, though they have been in and out of foreclosure a few times during that period. It’s not just the judicial foreclosure states; a $350,001 loan in Compton, CA also hasn’t made a payment in over a year and there is no pending foreclosure.

There is every reason to think the losses will be higher for these zombie borrowers than on the recent foreclosures. First, every month a borrower does not pay the servicer pays the trust anyway, though the servicer is then reimbursed the next month, mainly from payments of other borrowers still paying. This depletes the good loans in the trust, so that the trust will eventually run out of money leaving investors holding an empty bag. And on top of that, when the foreclosure eventually occurs, the servicer also reimburses himself for all sorts of fees, late fees, the regular servicing fee, broker price opinions, etc. Longer times in foreclosure mean more fees to servicers. Second, the odds are decent that the servicers are holding off on foreclosing on these homes because the losses are expected to be particularly high. Why would servicers delay in these cases? Perhaps because they own a portfolio of second mortgages. More sales of real estate that wipe out second liens would make it harder for them to justify the marks on those loans that they are reporting to investors and regulators. Revealing how depressed certain real estate markets were if shadow inventory were released would have the same effect.

These loans will eventually end up either modified or foreclosed upon, but either way there will be substantial losses to the trust that have not been accounted for. Of course, this assumes that the codes and status fields are accurate; in the case of the Guerreros’ loan the write-off – with legal fees for the fancy lawyers who can’t figure out why assignments are needed to the trust – is likely to be enormous. How much? Nobody except Ocwen knows, and they’re not saying.

Knowing that an estimated loss of 77%, is if anything an optimistic figure, even before we get to the unreported losses on the Guerrero loan, it seems difficult to understand why Ocwen wouldn’t first try loss mitigation that results in a lower loss severity. If they wrote-off half the principal of the loan, and decreased interest payments to nothing, they’d come out ahead.

Servicers give lip service to the notion that foreclosure is an option of last resort but, only when recognizing losses, do their words seem to sync with their behavior. But it’s all about the incentives: servicers get paid to foreclose and they heap fees on zombie borrowers, but even with all sorts of HAMP incentives, they don’t feel they get paid enough to do the work to do modifications. Servicers are reimbursed for the principal and interest they advance, the over-priced “forced placed insurance” that costs much more and pays out much less than regular insurance, “inspections” that sometimes involve goons kicking in doors before a person can answer, high-priced lawyers who can’t figure out why an assignment is needed to bind a property to a trust, and a plethora of other garbage fees. They’re like a frat-boy with dad’s credit-card, and a determination to make the best of it while dad is still solvent.

Despite the Obama campaign promise to bring transparency to government and financial markets, the investors in trusts remain largely unknown, so we’re not sure who bears the brunt of the cost of Ocwen’s incompetence in loss mitigation (to be fair Ocwen is not atypical; most servicers are atrocious). But, ACE2007-HE4 has a few unique attributes allowing us to guess who is affected.

ACE2007-HE4 is named in a lawsuit filed by the Federal Housing Finance Agency (FHFA), which has sued ACE, trustee Deutsche Bank, and a few others citing material misrepresentations in the prospectus of this trust. As pointed out in the prior article, both the Guerreros’ first and second loans were bundled into the same trust – so there were definitely problems – though the FHFA does not seem to address that in their lawsuit.

With respect to ACE2007-HE4, the FHFA highlights an investigation by the Financial Industry Regulatory Authority (FINRA), which found that Deutsche Bank “‘continued to refer customers to its prospectus materials to the erroneous [delinquency] data’”even after it ‘became aware that the static pool information underreported historical delinquency rates.”

The verbiage within the July 16, 2010 FINRA action is more succinct: “… investors in these 16 subsequent RMBS securitizations were, and continue to be, unaware that some of the static pool information .. contains inaccurate historical data which underreported delinquencies.” FINRA allowed Deutsche Bank to pay a $7.5 million fine without either admitting or denying the findings, and agreed never to bring another action “based on the same factual findings described herein.”

Despite the finding and the fine, FINRA apparently forgot to order Deutsche Bank to knock off the conduct, and since FINRA did not reserve the right to circle back for a compliance check maybe Deutsche Bank has the right to produce loss reports showing whatever they wish to.

It is unlikely that Deutsche Bank had trouble paying their $7.5 million fine since the trust included an interest swap agreement that worked out pretty well for them. Note that these swap agreements were a common feature of post 2004 RMBS. Originators used to retain the equity tranche, which was unrated. When a deal worked out, that was nicely profitable because the equity tranche would get the benefit of loss cushions (overcollateralization and excess spread). Deal packagers got clever and devised so-called “net interest margin” bonds which allowed investors to get the benefit of the entire excess spread for a loan pool. The swaps were structured to provide a minimum amount of excess spread under the most likely scenarios. But no one anticipated 0% interest rates.

From May, 2007, when the trust was issued, to Oct., 2007, neither party paid one another. In Nov., 2007, Deutsche Bank paid the trust $175,759.04. Over the next 53 months that the swap agreement remained in effect the trust paid Deutsche Bank $65,122,194.92, a net profit of $64,946,435.88. Given that Deutsche traders were handing out t-shirts reading “I’m Short Your House” when this trust was created, I can see why they’d bet against steep interest rates over the next five years, as the Federal Reserve moved to mitigate the economic fallout of their mischievousness with low interest rates.

In any event, getting back to Fannie Mae and Freddie Mac (the FHFA does not disclose which), one of the GSEs purchased $224,129,000 of tranche A1 at par; they paid full freight for this fiasco. Since this trust is structured so that losses are born equally by all A-level tranches once the mezzanine level tranches are destroyed by losses, which they have been, to find the party taking the inflated losses you just need to look in the nearest mirror. Fannie and Freddie are, of course, wards of the state so it is the American taxpayer that gets to pay out the windfall to the Germans. In this we’re like Greece, albeit with lousier beaches and the ability to print more money.

If the mess with the FHFA and FINRA were not enough, ACE2007-HE4 is also an element in the second 2007 Markit index, ABX.HE.AAA.07-2, a basket of tranches of subprime trusts that – taken as a whole – show the overall health of all similar securities. This is akin to being one of the Dow-Jones companies, where a company has its own stock price but that price also affects an overall index that people place bets on. Tranche A-2D, the lowest A-tranche, is one of the twenty trusts in the index. Since ACE2007-HE4 is structured so that all A-tranches wither and die together once the mezzanine level tranches are destroyed it has the potential to weigh in on the rest of the index. Therefore, the reporting mess – already known to both the FHFA and FINRA – stands to be greatly magnified.

The problems with this trust are numerous, and at every turn, the parties that could have intervened to ameliorate the situation failed to take adequate measures.

First there is the botched securitization, where a first and second lien ended up in the same trust. Then, there is failure to engage in loss mitigation, with the result that refusing to accept the Guerrero’s short-sale offers or pleas for a modification, resulting in a more than 100% loss. Next, there is defective record-keeping related to that deficiency and others like it. And the bad practices ensnarled Fannie /Freddie when they purchased almost a quarter billion dollars of exposure to these loans. Then there’s the mismanaged prosecution by FINRA, where they did not require ongoing compliance, monitoring, or increasing fines for non-compliance. There’s the muffed FHFA lawsuit, where the FHFA did not notice either the depth of the fraud, namely two loans for the same property in the same trust, and that the reporting fraud they cited continues. I’m not sure if the swap agreement was botched, but you’d think FINRA and the FHFA would and should do almost anything to dissolve it while it was paying out massive checks every month. Finally, returning full circle, there’s the fouled up foreclosure that the borrowers fought only because negotiations failed that resulted in a the trust taking a total loss on the mortgage plus paying serious legal fees.

It is an understatement to say this does not inspire confidence in any public official, except Judge Williams, the only government official with the common sense to lose patience with scoundrels. We’d almost be better off without regulators than with the batch we’ve seen at work.

US taxpayers would have received more benefit by burning dollar bills in the Capitol’s furnace to heat the building than we received from bailing out Fannie, Freddie, Deutsche Bank, Ocwen, and the various other smaller leaches attached to the udder of public funds. We could and should have allowed the “free market” they worship to work its magic, sending them to their doom years ago. That would have left investors in a world-o-hurt but, in hindsight, that’s where they’re ending up anyway with no money left to fix the fallout. It is long past time public policy makers did something substantive to rein in these charlatans.

My six year-old daughter understands the concept of limiting losses to the minimum, and apportionment of those losses in the name of fairness. Maybe Tim Geithner should take a lesson from her about this “unfortunate” series of events, quoting Judge Williams, before wasting any more money that my daughter will eventually have to repay.

Re the swap. These agreements are fairly standard. I suspect that the swap you’re talking about is “basis swap”, swapping mortgage receipts (expected or actual), for LIBOR+/-spread (then you can have another swap(s) that swap it into a fixed coupon/different currency etc.). At a first glance, it’s not entirely unreasonable – if you promise your bondholders a coupon, swap like this guarantees that you can pay the coupon no matter what. Also, these (basis) swaps are usually done between the trust and the originator of the mortgages (the reason being that the pool standing behind the bonds is overcollateralised, and the issuer doesn’t usually want to give up all the extra income from overcollateralization – they just want to use the principal of the mortgages as the extra collateral).

Of course, the problem is that these swaps are pretty hard to model (which means, if someone else than they issuer is taking on the swap, that they take a huge risk margin), so it can end up being hugely profitable.

But especially now, it can actually end up being hugely unprofitable to the banks, courtesy of rating agencies. All rated securitization deals have downgrade-collateral triggers. That can be say at BBB+ or thereabouts, where all of sudden the bank provider of the swap needs to post collateral which can look like say max(percentage of the notional + value of the swap ,0). So say the bank did 2bn swap with the trust, which is now 100m in the money to the bank. If the rating requirements are that the bank has to post 10% of notional, then the bank has to raise 100m in cash/securities and post it to the trust – even though in practice the trust owes money to the bank. Raising 100m is not cheap for banks that are at around BBB, and likely you have to do it for more than one transaction.

Moreover, with say UK banks, FSA liquidity rules require that you pre-fund this volatility cushion when you’re two notches above downgrade. That means most of the UK banks now have to raise billions of sterling (at quite a cost) which they can do nothing with (and earn very little on it). Talk about balance sheet (and PnL) drag..

Yet another example of how illusion of “security” works on individual basis, but causes problems when there are systemic issues.

This is one of the most nonsensical whitewash attempts I have ever read and you should be ashamed for posting it here, where these “swaps” have been exploded for the shams and cons they are for going on four years. Had the Fed not stepped in with a blank check in favor of the scoundrels hiding behind this kind of drivel, every one of these banks would have been liquidated and every one of those traders would be behind bars for a sentence which would make however much money he made relevant only in the lives of his heirs.

“Swaps” is a very very wide term. Indeed, derivative is a wide term (and, in case you missed it, derivatives have been around for at least 2500 years, likely longer).

Securitization swaps are different from even vanilla interest rate swaps, and have nil, zilch, nada in common with credit swaps that have been widely discusse on NC (and on which I have even more extreme views than Yves).

A point you might make there is misseling (financial products should be treated similar to drugs, but that’s a different story), but in these transactions the parties tend to be related. The investors could be screwed up by the relatedness of the parties, but on the other hand, the swap gives them a coupon then wanted/asked for, so they can hardly complain as long as the bank pays what it commited to.

If your coop bank advertised 2% on a saving account and then pays you the 2%, but lent it on a floating rate that now pays 4%, would you complain?

Moreover, if you actually read my post instead of triggering pavlova reflex on the word swap, you’d see that banks+rating agencies dug themselves into an unpleasant hole with these – which is hardly a whitewash.. My comment below (which should have been really a reply to my main comment) is also speculating that that might even be one of the reasons why they don’t want any of the trusts going bust before the mortgage pool is eliminated, as that could move them from paper profits to realised losses.

so please, next time, do what quite a few commenters on this blog do and engage brain before letting your reflexes take over.

We really haven’t fixed very much with regard to securitizations. The banks are not require to write down 2nd lien positions ahead of 1st liens, there’s a great deal of transparency still missing from the servicing reports, the gov’t is using this mess to come up wiht new ways to subsidize the banking industry, we still have the MERS issue and the proper transfer of mortgages to trusts and it’s all too often that we’re not sure if bond holders or senior bond holders are first priority for the servicers when engaging in mods. Add to that gov’t mortgage rates that are so low that we’ve taken away all incentive for a rebirth of a private mortgage market which means nobody will need to fix the old rules.

Michael Olenick said; “Having mastered the notion of loss mitigation and fairness, and because it’s not nice to torture six year-old children with experiments in economics, I allowed her to keep all four.”

Looking beyond the “torture” of asking your daughter for a portion back…

By allowing her to keep all four quarters you negated her natural notion of fairness and replaced it with Daddy love manipulation; thus setting the stage for her easy acceptance of unfair Tim Geithner corrupt state love manipulations; acceptance of FICO scores, late fees, the regular servicing fee, broker price opinions, scam unfair rule of law, yada yada yada…

Oh, and to add to this – for most pre-2008 trusts (i.e. pre-Lehman collateral blowup), the collateral posted by the bank gets comingled with trust funds at default (of the note), as (for exampl) it turns into termination amount which is then subject to credit waterfal.

The swap providers are usually (in RMBSes) ranked below noteholders, thus their collateral would end up making good on the notes and the bank could wave it goodbye. Bank loses twice, first on the swap income (which can be easily in 10 or 100s of m) and then on the collateral of volatility cushion (which again can be in 100s of m).

before I start, let me say that I have never met Mike, but have quite a few friends in the foreclosure fights here in Florida who speak highly of him, but…this piece is a perfect example of why a little information is not a good thing. His lack of depth of knowledge of what goes on inside a loan pool, in spite of the “partners” he is working with who seem to know even less…this feels like the nonsense that ran aroung the internet after I tore apart MERS corporate structure and all of a sudden there were lunatics telling you they could make your loan just “go away”…first off…just because someone gets a ruling that says the case is dismissed with prejudice, does not make it a loss…most parties will pay off the loan in one form or another within 10 years…so the loan now should bounce into a zero note type traunche in the loan pool. also, the losses he is insisting on may not have to do with a foreclosure, quite often, a foreclosure mills sends some johnny scungilly guacamole to serve the foreclosure papers, and in florida, the vast majority of these “process servers” tell the homeowner that the sheriff is gonna be here in 20 days and throw your stuff on the street…a percentage of the homeowners accept this nonsense and bail in two weeks…and the empty house becomes a teardown…that is how one can lend 65K and end up with 95k in fines and demo expenses…and the focus should be on the swaps and other derivatives…that is why nothing is getting settled…not for the punk pennies that the servicers are stealing…its the meatie dollars that the small town pensions are losing in phony derivative contracts…yes phony…almost all of these “derivative losses” stem from the pay for play prosecutions that are being quietly settled…just because Khuzami set up a teflon situation when he was running DB americas legal circus, does not mean it is real…in almost all cases, the “deficits” that are being “proclaimed” in city and county governments where the “pensions” are in trouble is just a bunch of whooeee…not one home loan has had one foreclosure where the lender starts by saying…oh…that 100k we got from aig at the beginning of the crisis, we are gonna just reduce it from our foreclosure claim in this case…on July 28, 2008, FM Watch / FM Policy Forum folded shop after finally putting the nail into the heart of freddie and fannie by getting some minor…or so it seemed, minor piece of legislation passed…five weeks later…fannie and freddie were closed up so that the government would not cash in on winning derivative positions…YES WINNING…what…you believe the nonsense about why fannie and freddie were shut down…they had WINNING derivative positions…but by yanking the rug out from under them,killing off the assets placed to cover the instruments, the rest of wall street got to save themselves from themselves…the ISDA close out contract is floating around the internet if you look around deep enough…the truth shall get you fleas…

See Comment by “Cadavre: Sun, 06/10/2012-19:26 for a potential plan, under section: “Is there a constitutional lawyer in the house?” It’s in a Comment on ZH to “Bill Buckler: ‘It’s GIGO Time on Wall Street'” and the comment is worth reading in full.

Michael, I really liked this post – in part because your little interlude with your daughter is both charming and enlightening. We may not be able to fix bad bankster behavior and lax regulators, but you are on your way to raising a fine young woman. Happy Father’s Day Michael!

Here’s my question for the courts. If the servicers are duty-bound to protect the interests of the trust, why are they engaging in more foreclosures than work-outs, short sales, and loan mods? Is the overall behavior of this servicer, over an array of trusts admissible as evidence of a breach of fiduciary responsibility? And sticking loans from borrowers with credit scores in the 500s without disclosure to investors is flat out fraud. Where are the handcuffs?

Apologies, but IMNSHO *all* our CongressCritters, POTUS, SCOTUS are in direct violation of above–since (almost) all Acts/Statutes/ExecutiveOrders/Regs/Code are “Unlawful”, and our eelected (hah, diebold) officials are all guilty if/when then accept the State/Gub’mt can/will initiate Force/Aggression upon its Sovereign People.

WeThePeople are the Kings and Queens, not God-like, and sinners at best ; However, the Agents of the State are *our* servants, and many complain that those with pensions are paid too handsomely .. for starters; I won’t even go into the Public/Private ORGY relationship between these Foreigners, these Traitors, these Treasonous M***F***ers! ..these Global wielders of Weapons of MassFinancialDestruction.

Apologies again — but am i the only one here thinking “outside the box”? surely not! but .. i mean, thinking about others’ (long-winded explanatory) posts would/might seem to deem otherwise–why is it so hard for those of higher education (which i’m going to guess is ~ atleast 80-90% here on NC) to accept and work with common sense?

Wow, Mike and Alex, that’s a lot to take in …
My question is this:
Haven’t I heard that many if not most of the securitizations are failed because the trustees did not take in the required documents at the inception or that the MERS bankers tried to assign mortgages to the trust after the cutoff date?
Where dos this put the trust, the investors and the homeowners’ mortgages?
Thanks for any enlightenment you can provide.
Best Regards,
Bob

The securitzation at inception problem is another red herring…the trust indenture act covers what does or does not have to be done with these ny common law or delaware statuatory trusts. Basically, to prevent the trustee from having any liabilities, the trust must follow, to the letter, the authorizations as prescribed in its instruction manual, commonly known as the PSA. The reason the trusts were held all loosy goosy is that there has to be instruments to place for margin requirements with derivatives…and so these “blank indorsed”(its an i not an e) home loans(improper under firrea) were the back bone of triple reverse split redo repos which required an “instrument” to be placed or purported to be available with a “custodian”…ala MF Global…(pick a card…any card)…now as to the homeowner, if you have an attorney who understands capacity and standing and can actually read through a securitization document and you are “lucky enough” to be getting foreclosed in the name of specific loan pool..then you might have a fighting chance. Or if your attorney knowns to track down the mystery name on the “blank indorsement” they might find, as we have, that the party named never placed that stamp on the document, and therefore, at least in floriduh, that assignment can be properly challenged as appeals court rulings on the issue require the party to be in the room and under direct authorization when a blank facsimile stamp is used, as is almost the case in each of these situations…and no…the assignment in blank has never been adjudicated as being improper in the Trust Indenture Act in respect to loan pool trusts…it probably will be in the next 12 months, but it aint happened yet. As to the MERS tax evasion system, we should force that mess shut in the next 6 months…forcing the empire to negotiate…I mean, expecting the larger institutions to fix that problem by mid 2013 in a massive wave of fixed for 8 years at 2.75% refis…new paper is the only way to clean up that mess…and there has to be an incentive for the sheeple to come and play…most people will refi and life will go on…most hippies gave up the commune life by 1977, so die hards talk smack, but reality is that most people just want to live their lives in peace…the wall street dinosaurs will go away along with fidel castro by 2014…and life will go on…remember…no one remembers chiang kai shek or paul robeson anymore…good luck and be well…

If the Wall Street dinosaurs really were going away, we wouldn’t be having these problems. But they’re corrupting the entire political and legal system for the purpose of hanging on a few… more… years….

They could get away with it. It’s happened before, historically. This usually led to deeply illegitimate governments which eventually got violently overthrown by a new strongman.

I don’t think that principal writedowns are big loss mitigators in the majority of these cases. These lenders such a profound inability to judge the value of the collateral and the ability and inclination of teh borrower to pay when they made the initial loan, it seems folly to expect them to do a better job now. For many of these borrowers job losses (or poor income in the first place) will prevent them from being current at a loan amount anywhere near to current house value. For those who bought as an investment, it’s not clear what would entice them to start making payments on a house that the appreciation fairy won’t be visiting for decade or more. So in many cases these loans will simply re-default and lose even more money after a principle writedown. Since these subprime operators wouldn’t know actual underwriting if it hit them in the head, I don’t think that writedowns (as opposed to short sales) will save all that much money.

I have my mortgage loan in the same trust and securities ACE 2007-HE4. I have a predatory loan, I had (80/20 loan) 100% financing. Ocwen/HSBC gave me a modification on first but only for 3 years adn we settled on second (I paid 10%).
I am in default since sep 2011 because my mod is finished and they do not want to modify again. Ocwen/HSBC tells me that my account in foreclosure but I am checking collat. reports to investors and they do NOT report my loan as in foreclosure, it has status “00” such as no changes. I paid an attorney and waiting for foreclosure sale date to fight Ocwen/HSBC.

What’s your ZIP code, original unpaid balance, and origination date? Sounds like you already found it but it only takes me a second to look at the history across all their reports. Wouldn’t be surprised to find another that’s not accurately reported.

You’d think between the fine to FINRA and the FMFM lawsuit they’d stop this, but FMFM is the largest bondholder and they may not want them to: the faster they report accurately the more quickly FMFM will have to recognize losses. More money for FMFM isn’t something Congress wants to hear, especially since they’re claiming that they’re “profitable” lately.

Thanks Michael for your message! I appreciate your help. You can look up my loan by zip. There is only my loan in zip code 96815.
Do you know what tranches is pool # ACE07HE4-4?
FMFM only bought A1- Group I.
I dont think my loan was bought by FMFM. Wells fargo (Master servicer) shows my loan is in Group II.

Right now I am deciding to take them (Ocwen, HSBC, Ace) to court or wait till they file foreclosure… I need to do more research regarding my investors. Ocwen denies my modification based on “the owner of your loan doesnt allow modifications”.